Transfers to FLP Included in Decedent’s Gross Estate for Estate Tax Purposes

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July 05, 2006

In Estate of Rosen v. Commissioner, T.C. Memo. 2006-115 (6/1/06), the Tax Court concluded that property transferred by a decedent’s revocable trust to a family limited partnership (“FLP”) was includible in the decedent’s gross estate under Sec. 2036(a)(1). In general, Sec. 2036(a)(1) includes in a decedent’s gross estate for estate tax purposes the value of transfers made by a decedent during his or her lifetime when the decedent has retained certain rights with regard to the possession of, enjoyment of or income from the transferred property. Sec. 2036(a) contains an exception to its application where the transfer is a bona fide sale for adequate and full consideration in money or money’s worth (the “bona fide sale exception”).

The FLP was formed approximately four years prior to the decedent’s death. The decedent (via her revocable trust) provided 99 percent of the funds of the FLP in return for a 99 percent limited interest. Decedent’s two children each transferred .5 percent of the funds to the FLP in return for a .5 percent general interest. During the decedent’s lifetime, more than two-thirds of the decedent’s interest in the FLP was gifted to her descendants.

The Tax Court first addressed whether the transfer by the decedent met the bona fide sale exception. The court dismissed the non-tax reasons the decedent’s estate urged as the reason for the decedent’s transfers to the FLP and determined that the exception was not applicable because: (1) the FLP engaged in no functioning business operation and did not respect partnership formalities; (2) there was no negotiation process among the partners in settling on the terms of the partnership agreement; (3) the FLP was not funded until almost 2½ months after the FLP agreement was signed; (4) the decedent transferred substantially all of her assets to the FLP; (5) after the transfer to the FLP, the decedent was unable to support herself without distributions from the FLP; (6) the only assets contributed to the FLP were marketable securities and cash; and (7) the decedent was of advanced age and in bad health at the time the transfers were made to the FLP.

The Tax Court next determined there was an implied agreement among the partners that the decedent would retain the possession and enjoyment of the assets transferred to the FLP because: (1) the FLP was a testamentary device and not a business operated for profit; (2) the relationship between the decedent and the assets transferred to the FLP did not change following the transfer of the assets to the FLP; (3) the assets were transferred to the FLP on the advice of counsel for estate tax minimization purposes; and (4) the purported loans from the FLP to the decedent were, in fact, distributions, not “debt” (the opinion analyzed factors when determining whether a loan is debt).

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While this case does not set any new precedent on the subject, it is an excellent case to review a quick summary of the development of the Sec. 2036(a)(1) argument with respect to FLPs.

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